Capital Expenditures

The age of propaganda is now upon us; where perception trumps the truth, until that is, the house of cards burns and falls, which it always does. With such blatant data manipulation going on, why shouldn’t we question the extent of stated “glut” in oil? The longer perception is distorted to create a false reality, the worse things will get in the end. We saw this before in 1999/2000 with the internet bubble and in 2008/2009 with the housing bubble, and it will not end well. If producers are dumb enough to get roped in to turning the spigot on when oil does rise (just as they appear to have done this morning) then, once again, prices won’t hold.

How is it that the company's GAAP EPS declined by a whopping 17%, from $0.66 to $0.55, and yet its non-GAAP EPS dropped by a tiny 1% from 0.88% to 0.87%? This is how...

Having plumbed the depth of 2-year lows in April, May's Empire Manufacturing printed a disappointing 3.09 (against expectations of a bounce to 5.00 from -1.19). This is the 4th miss in a row and for context is the same level as we dropped to in January 2008. Number of employees and prices paid (and received) tumbled, new orders edged higher but crucially 'hope' plunged back to 3-month lows. Furtures expectations for CapEx and Tech Spending also collapsed.

With the Federal Reserve now indicating that they are "really serious" about raising interest rates, there have come numerous articles and analysis discussing the impact on asset prices. The general thesis, based on averages of historical tendencies, suggests there are still at least three years left to the current business cycle. However, at current levels, the window between a rate hike and recession has likely closed rather markedly.

As with everything in life, there are winners and losers, and the recent rout in the oil market is no different. The four flip sides below should be closely monitored in the coming months, for the oil market will be impacted by these factors – regardless of if they change their tune, or become a broken record.

In reviewing the financials of one of the largest shale producers in the United States, Whiting Petroleum, we can’t help but notice the parallels to the .COM era of 1999 which, to some extent, has already returned to the technology and biotech sectors of today.

Investors are getting crushed.

The current equities bull run seems unstoppable. No amount of geopolitical concerns, Greek default fears, rate hikes, US dollar strength, crude oil price volatility, Russian sanctions or whatever else you can think of can put a dent on it. Perhaps we should take a step back and try to understand what is driving this strength. OK, we know that central banks continue to spike the punchbowl, but what is the actual transmission mechanism that directs all this liquidity into equities – as opposed to commodities for instance, which continue to struggle?

Well, the leak (which ironically came out on Twitter only, and not Facebook) was right, and the full story is even worse than Selerity reported:TWITTER 1Q LOSS PER SHARE 25C; TWITTER INC 1Q ADJ. EPS 7C , EST. 4C.
That much we knew. Here is where it gets worse:

• TWITTER 1Q REV. $ 435.9M, EST. $456.2M
• TWITTER SEES 2Q REV. $470M TO $485M, EST. $538.1M
• TWTR SEES YR REV $2.170B-$2.270B, SAW $2.3B-$2.35B, EST $2.37B

And now perhaps someone will ask how much of Facebook's 1.4 billion "users" are actually real.

"If 47% is the final percentage for the quarter, it will mark the lowest percentage of companies reporting sales above estimates since Q1 2013 (also 47%). Since Q3 2008, the percentage of companies reporting sales above estimates has finished below 50% only 6 times," FactSet notes. In a world where buybacks are king and capex is now a four letter word in more ways than one, this is not surprising.

One must understand that the easy money via QE from the Fed and zero interest rates allowed many shale players to burn free cash flow while showing operationally net of capital expenditures (which were funded by cheap flowing monies via FED) cash generation. To be clear, that model is now broken as the era of free Fed money appears to waning as both QE, and soon, zero rates become a thing of the past. The cost of capital is no longer falling but is now rising through higher bond yields and/or lower stock prices. The madness that is occurring in financial markets on discounting these events despite very weak, almost recessionary economics, boggles the mind.

Saudi Arabia is not trying to crush U.S. shale plays. Its oil-price war is with the investment banks and the stupid money they directed to fund the plays. It is also with the zero-interest rate economic conditions that made this possible. Saudi Arabia intends to keep oil prices low for as long as possible.

In recent weeks the sell side analysts who cover energy have become so complacent that they merely plug in the current strip prices into their earnings models for E&P companies. Not one, except Mike Rothman at Cornerstone Analytics, is questioning the “why?” or “how?” of what is occurring. The 200 or so players who effectively control the oil futures market have changed behavior and expectations as the oil price curve has collapsed. Prices from late 2016 into 2018 are essentially flat in the low to mid 60s, believe it or not, which would essentially bankrupt most of OPEC, US conventional oil, part of US shale and deep offshore drilling. So ask where is the oil going to come from? Yet the madness continues until investors realize E&P companies need a higher price to justify investments in the space.

The present oil price collapse is because of over-production of expensive tight oil. The collapse occurred because of the inability of the world market to support the cost of the new expensive oil supply from shale, oil sands and deep water. The problem is structural and systemic and firmly rooted in the irresponsible funding of under-performing U.S. tight oil companies since at least 2010. The first step to price recovery is the severing of capital supply to companies that could not fund their operations from cash flow when oil prices were more than $90 per barrel. If this does not happen, we could be in for a long period of low oil prices.

Thomas Jefferson is credited with the following sage advice, “The central bank is an institution of the most deadly hostility existing against the Principles and form of our Constitution. If the American People allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the People of all their Property until their Children will wake up homeless on the continent their Fathers conquered.” And so it seems sometimes the answer is right in front of us all along and we just fail to see it.